Housing Affordability – A Dose of Reality

Summary:
Restless Peasants
First, a few quick words on Brexit. Being the always positive and optimistic person that I am (big grin), I see one very positive outcome of Brexit – it is a revolution without bloodshed.
The peasants are getting restless…
Illustration via squadron.com
For once, I’m not digressing. Brexit has a lot of parallels with housing affordability in the US. Brexit is a clear illustration of how politicians, policy makers and the establishment have lost touch with the peasants, and the peasants are getting restless. Allow me to elaborate.
The State of Affordability
Down-payment – Down-payment is more of an issue for entry level buyers than for trade-up buyers. When affordability was first measured, a 20% down-payment was very common. Forget nothing down sub-prime loans, a 3% to 5% FHA or agency loan is the new norm for the entry level buyers. The current trend is toward even smaller down-payments.
Mortgage payments – rates have never been lower and it looks like the Brexit will drive them even lower. In other words, it has never been cheaper to cover debt service. Are zero interest, or even negative interest mortgages possible?
Credit Scores – once insignificant, credit scores are now used as hurdles for qualification. Once upon a time, young persons entering the workforce would have no credit history.

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Restless Peasants

First, a few quick words on Brexit. Being the always positive and optimistic person that I am (big grin), I see one very positive outcome of Brexit – it is a revolution without bloodshed.

The peasants are getting restless…

Illustration via squadron.com

For once, I’m not digressing. Brexit has a lot of parallels with housing affordability in the US. Brexit is a clear illustration of how politicians, policy makers and the establishment have lost touch with the peasants, and the peasants are getting restless. Allow me to elaborate.

The State of Affordability

Down-payment – Down-payment is more of an issue for entry level buyers than for trade-up buyers. When affordability was first measured, a 20% down-payment was very common. Forget nothing down sub-prime loans, a 3% to 5% FHA or agency loan is the new norm for the entry level buyers. The current trend is toward even smaller down-payments.

Mortgage payments – rates have never been lower and it looks like the Brexit will drive them even lower. In other words, it has never been cheaper to cover debt service. Are zero interest, or even negative interest mortgages possible?

Credit Scores – once insignificant, credit scores are now used as hurdles for qualification. Once upon a time, young persons entering the workforce would have no credit history. They often have to get a small limit credit card or a gas card, and use it enough to build up a credit history. Today, young people start out as sub-prime credits as a result of student loans, car leases and credit card charges that were freely given to them. As the credit quality of the average household declines, the hurdle is simply lowered to accommodate the unqualified. Freddie and Fannie will accept credit scores as low as 620. Do you have any idea how many payments you have to skip to get a score that low?

Debt to Income Ratios – In theory, Fannie’s maximum DTI ratio is 36%, but maybe 45% if certain conditions are met and it has the flexibility to go to 50% if there are strong compensating factors.

The end result of 45 years of fiat money and unbridled credit expansion – the “common man” has been priced out of a middle class lifestyle – click to enlarge.

No need to go any further, you see what I am getting at. In theory, housing could not be any more affordable than it is today. Take away high priced areas such as coastal California or NY City, which have never been considered affordable, and the national median is still below $200,000. That can get you a house in cities like Phoenix, Charlotte, Vegas, Houston and the central valleys of California.

A $200,000 purchase is nothing more than $10,000 down and $1,200-$1,500 per month. That should be very comfortable for households earning the median income of around $50,000. Putting $50,000 in the proper perspective, a California couple making minimum wage will soon be making $62,400 once the minimum wage is raised to $15/hour.

A Dose of Reality

The MacArthur Foundation recently released its 2016 How Housing Matters Survey. The report is short and to the point, well worth glancing over. Here are some key points:

[A]nd a very significant majority (81%) of Americans continue to believe that housing affordability is a problem in America today, with six in 10 characterizing it as a serious problem.

The proportion of Americans believing the housing crisis is over had increased steadily, from 20% in 2013, to 25% in 2014, to 35% in 2015. This year it decreased to 29%.

More than nine in 10 (94%) adults believe that stable, affordable housing is important to being able to achieve a secure middle-class lifestyle, yet nearly seven in 10 (68%) think it is harder to secure such housing today than it was for previous generations.

The MacArthur survey also has many thought provoking charts. It has received little media coverage but I urge you to take a look (only 36 slides). To me, the survey illustrates that affordability is a symptom, the underlying problem is household finances, which are stressed to the max.

The sacrificial data table – click to enlarge.

Why are sacrifices needed? Because these households have chosen a lifestyle that they cannot afford and therefore have to juggle expenses to make ends meet. Unlike the governments of this world, just printing more money is not an option. Households should budget according to the resources they have, with reserves, then everything is as planned and affordable.

Hand to Mouth

The survey results show that the masses believe affordable housing is important, and the government is not doing enough about it. So the following table lists the policy approaches to addressing the problem. No wonder Bernie Sanders managed to hang on in the presidential campaign for so long, we are a nation of socialists.

More free stuff please! – click to enlarge.

Missing from the list above are the things consumers can easily do to help themselves. Cut expenses such as a new car lease every 2-3 years, when there is nothing wrong with the old car. Maybe a big screen TV in every room is excessive. Are vacations funded by credit card debt really necessary?

Now imagine a financial stress test for every household, with the results grouped into tiers. Pertaining to real estate, the high end has plenty of cushion to absorb any form of economic downturn. Conservative savers with little or no mortgage debt can also hang in there, even though their life style may have to be tweaked.

It is the bottom tier that is most at risk. The loss of a job or a similar calamity may cause them to default. Any decline in property values may push them into negative equity status.

More free stuff please, continued… – click to enlarge.

Now how big is this lower tier? How big a blow can it absorb? I know of no study that provides a quantified answer. My guess is that there are not only lower income households in this lower tier, but that many middle class households are also at risk. They may have decent income, but many have taken on too much debt.

Public perceptions about the state of the housing crisis have recently worsened again – after a full 8 years! – click to enlarge.

Adding to my worries is the exhaustion of government stimulus. The central banks of US, Japan, China and EU have pushed the envelope to the limit already. Their credibility is seriously in doubt and any future bailouts may backfire. The Fed has over $4 trillion in assets on its balance sheet.

The ECB’s QE is running out of qualified assets to purchase. The BoJ is approaching majority ownership of Japan’s government debt. China, according to some gurus such as Kyle Bass, has a monstrous debt bubble. Over $11 trillion, or a quarter of all sovereign debt in the world pays negative interest.

Conclusion

In conclusion, many consumers are living a lifestyle they cannot afford, all because policy makers are flooding them with cheap credit, hence the consumption economy. Housing is the largest household debt item. Is this sustainable? Brexit is supposedly going to pop the UK housing bubble, especially the London bubble.

Maybe we can sit back, watch and learn.

These particular peasants are still lost in the woods somewhere, so no reason to panic yet…

Ramsey Su was a real estate broker who specialized in all aspects of foreclosures. His career started during the Volcker era in the early 1980s. In addition to acting as broker for bank owned properties, Ramsey also acted as consultant, court appointed receiver, manager for distressed properties, work outs and as a real estate investment adviser. Currently, Ramsey is an independent analyst, focused on the rapidly changing world of real estate today.